2016-10-31

When Sobeys headed to Western Canada to snap up Safeway for $5.8 billion, it was on top of the world. Since then, it has booked billions in write downs and dumped its CEO. Why did everything go so terribly wrong?

Carole Taylor’s red-pepper complaint may not sound like a big deal. But multiply it by thousands of customers, and you’ve got the biggest retailing fiasco in Canada since Target Corp.’s northern foray self-destructed.

For Stellarton, N.S.-based Empire Cos. Inc., the parent of Sobeys, a dream acquisition has turned into an existential struggle. After a string of costly missteps and some bad timing that culminated in the company’s CEO stepping down, Sobeys finds itself having to reinvent itself to woo customers back to Safeway.

It won’t be easy. In the past two quarters, same-store sales in its West business unit, which includes Safeway and Sobeys stores, skidded 3.6% and 3.9% respectively. That’s raised questions about how long the bloodletting can continue. The company’s counterpunch is a major price-cut initiative, as advertised on those in-store signs. For a full-service grocer like Safeway, with its higher costs per square foot of store space, it’s a big gamble.

It was hailed as a masterstroke when Empire acquired Canada Safeway in 2013 following exclusive talks with its American owner initiated by CEO-to-be Marc Poulin and then-CEO Paul Sobey under the code name “London.” The purchase instantly gave Sobeys girth in Western Canada and made it Alberta’s No. 1 supermarket chain operator. Rivals, including Ontario- and Quebec-focused Metro Inc., had also coveted Safeway, with its 213 full-service stores from Vancouver to Thunder Bay, four major distribution centres, 12 manufacturing plants and $1.8-billion worth of prime real estate.

It wasn’t immediately evident for months after the takeover, but Sobeys had problems at each step of the chain from warehouse to cash register—and some of these hitches existed before the deal. Safeway, which struggled in its own home U.S. market and would soon be taken over itself, had treated the Canadian business as a cash cow while investing as little as possible in modernizing the operations, says Kenric Tyghe, retail analyst at Raymond James. “What Sobeys thought they were buying, and what Sobeys ended up getting, turned out, I think, to be two different assets,” Tyghe says.

Supply-chain problems were a particular drain on efficiency after the deal. Sobeys made a transitional arrangement with Safeway to maintain U.S.-based produce sourcing and buying. As the arrangement expired, Sobeys took over purchasing and immediately suffered glitches as new buyers became responsible for keeping fruit and vegetables on the shelves. The result is what Taylor, the Calgary shopper, experienced with her peppers. “We basically had, for a number of months, difficult replenishment of our stores in produce,” Poulin explained in late June. “The quality of what we were putting out for the customers was impacted as a result of that.”

Such issues, and empty shelves as a result of supply-chain snafus, are business killers because customers have a low tolerance for being inconvenienced, Ricker says. “I go to your store needing bananas, and you don’t have any? Are you kidding? Now I’m going to have to go somewhere else,” she says.

That the IT side of the supply chain would be a hitch should not have been a surprise. Following acquisitions of new businesses at large retailers, massive IT systems must mesh thousands of SKU, or stock keeping unit, codes, and that can lead to myriad glitches. Enterprise software snafus have upended the supply chains and internal systems of other Canadian retailers, including Loblaw and Target Canada. In fact, Sobeys itself abandoned a SAP system in 2000 following a system crash, resulting in a $50-million writedown. It returned to the German software provider—whose systems are used by many of the world’s largest corporations—a few years later. At Safeway, Sobeys installed new SAP software and point-of-sale technology that frustrated staff, some to the extent that they tried to go back to the old systems. Sobeys also relocated all western headquarters functions to a centre in Calgary—just a few years after setting up regional hubs in cities such as Edmonton and Winnipeg. These changes, too, took a toll on employee morale.

The confusion in the ranks didn’t help supplier relationships, either. A marketing representative at one Canadian-based manufacturer said that, even up until this year, it took as long as six months for some distributors to get a meeting with key buyers who could agree on and finalize store-level promotions, such as a sale or special displays. That hurt his brand’s sales. “A lot of the budget I had to invest at Safeway was basically left because nobody could make a decision on promotional activities,” says the rep, who spoke on condition of anonymity, fearing loss of future sales.

What’s so surprising is how long the woes stayed under wraps. At the end of the 2014 fiscal year, Poulin said Safeway was being successfully integrated into the Sobeys fold. It was becoming more efficient and costs were coming down throughout the organization. In fact, by the end of the first year, Safeway and Sobeys in Western Canada were already well down the road to delivering half of the promised synergies. Sobeys said it would close 50 underperforming stores in the company’s network, 60% of them in the West. Overall sales jumped 20.6% accounting for the Safeway takeover, and 2.2% excluding it.

The following year, revenues climbed another 14.2%. Things were so rosy for Empire that it treated shareholders to a dividend increase. Investors bid the shares up to the point where the company opted to split the stock.

But in Sobeys’ 2016 fiscal year, everything seemed to go wrong at once.

In March, Empire stunned investors by writing down $1.6 billion of the value of Safeway as customers drifted away. Just three months later, it lopped another $1.3 billion from its book value, meaning half the worth of the acquisition had evaporated within just three years. It’s clear that Sobeys materially overpaid for Safeway

So for the second time, a major retailer has been crippled by lack of supply chain solutions and an SAP system that just didn't do what it's promised.